Why 6% Interest Is Really 50% Interest

Uncle Pennybags
Uncle Pennybags

I recently graduated with $175,000 USD of debt. I have a lot to say about college debt, how to avoid it, and how to pay it off, but for this post I want to keep it simple.

Let’s say you have a hundred thousand dollars in debt at 6% APR. How much interest will you pay?

The banks want you to believe that it is a tiny 6%; just 6 cents on the dollar. Well that is one way to look at it. Let’s do some math.

$100,000.00 of debt, multiplied by 6% APR….  $100,000 x 0.06 = $6000. So do you pay $6000 interest? Yes and No.

APR means Annual Percentage Rate. Annual being the keyword here. They charge you interest again and again every year. Did you ever think of it this way?

$6000 of interest divided over 12 monthly payments is $500 per month. Your monthly payment will be about $1000 on average, but interest gets paid first. So you pay the bank $1000 and $500 goes to interest and $500 goes to principle.

Did you see that? $500 of your $1000 goes to interest. That’s half! 50% of your money just went to the bank for profit.

There is another way to look at it as well. As you eventually pay more principal balance down then the percent of interest will decrease. Still, if you pay that $1000 every month you will end up giving the bank $135,000 on your $100,000 loan. That is 35% interest.

The bank isn’t bad for selling their product in the most favorable terms, every business does that. But you should know, you will be paying more than the 6%. It is probably most fair to say that a “6% loan” is really a 35% loan.